Oil remains range bound, but for how long?
Fundamentals
Oil futures traders have had to switch gears the past few months, as the wild price swings seen in most of 2008 have drastically subsided during the first quarter of 2009, as conflicting fundamentals are keeping prices range bound. The current recessionary environment we are in has curtailed domestic and international Oil demand. U.S. Crude Oil inventories are at their highest levels since 1993, and 13 percent higher than the five year average. Demand from outside the U.S. has also fallen sharply, as both the European and Japanese economies have been hit hard, if not harder by the current global recession. Yesterday's EIA Weekly energy stocks report showed U.S. Crude Inventories rose by just over 2.8 million barrels last week, as refinery operating rates fell by 0.3% to 81.7%. These generally bearish fundamentals are countered by announced production cuts out of OPEC of 4.2 million barrels per day, with member compliance running between 70 and 80 percent. The mass amounts of economic stimulus being brought forward by world governments have spurred a minor "flight to commodities" by some investors fearing soaring inflation once the stimulus works its way through the economy and as an economic rebound occurs. The U.S. added another 1.7 million barrels to the strategic petroleum reserve last week, on top of the 1.8 million barrels added the week before. Supplies in Cushing, Oklahoma, the delivery point for the NYMEX Crude Oil contract, fell by an additional 800,000 barrels after last week's surprising draw of 2.2 million barrels. Until actual increases in demand for Oil begin to surface or the economic situation takes a major turn for the worse, it appears that both Oil bulls and bears will find it difficult to swing price momentum their way, and the current range bound trade may continue for awhile longer.
Traders who believe Crude Oil prices will remain range bound may choose to consider selling strangles in Crude Oil options. A short strangle is the sale of a call option and the sale of a put option at different strike prices, but for the same contract month. The high for May Crude in 2009 was 58.31 and the low was 39.42. An example of this trade is selling a May Crude 59.00 call at 0.25 and a May 39.00 put at 0.33 for a total credit of 0.58 or $580 per contract, with May Oil at 48.33 as of this writing. The trade would be profitable (before commissions) if May Oil futures remain below 59.58 and above 38.42 at expiration on April 16th, with the maximum gain being the premium received minus any commissions and fees. Traders selling strangles are looking for volatility to fall, and time decay will aid this trade. Traders must remember that selling strangles can be quite risky, as there is a potential for unlimited losses if prices were to move sharply beyond the strikes of the short options. Good risk management is essential for all traders and especially for those utilizing short option strategies.
Technicals
Looking at the daily chart for May Crude, we notice the nearly 4-month long trading range Oil has been in since late December 2008. Prices are not currently right in the middle of this nearly $20 range, as neither bulls nor bears seem to be able to keep control for long. Prices have recently fallen below the 20-day moving average, and the 14-day RSI has fallen below the 50 level, which may give the near-term edge to the bears. Support remains at the contract lows of $39.42 in the May futures, with resistance found at the January highs of $58.31.
Mike Zarembski, Senior Commodity Analyst
